2/08/2007 @ 7:20PM

Will EMI Set Its Music Free?

Apple
chief
Steve
Jobs
Steve Jobs
shook up the music business on Tuesday by calling on the major record labels to drop usage restrictions on song downloads.

But at least one of the big four music companies had been already preparing to do just that. In recent weeks EMI Group has been in advanced negotiations to sell music downloads without “digital rights management” (DRM) restrictions via multiple online music vendors, including
RealNetworks
,
Yahoo!
, News Corp.‘s
MySpace and
Napster
, say people familiar with the situation. But on Thursday, those negotiations slowed dramatically, putting a potential deal in jeopardy, according to multiple sources.

EMI representatives said it was the company’s policy not to comment on rumors or speculation.

Industry insiders have been buzzing for months that one of the majors was seriously exploring the possibility of freeing its downloads from restrictions that determine how many times a song can be played and on what kind of machine.

EMI and other labels have already experimented with selling a handful of songs from artists like Norah Jones and Jessica Simpson in unencrypted MP3 format, which can be played on any computer or portable music player and can be copied freely. But sources say EMI was talking to music vendors about doing the same thing with much of the company’s online catalog.

A deal would have been a bold move for troubled EMI, which is in the midst of a painful restructuring that included the ouster last month of two of its top executives. Until now the company and its major competitors–Vivendi’s Universal Music Group, Sony BMG Music and Warner Music Group–have maintained a united front on the need to preserve usage restrictions on music downloads to combat piracy.

“Let me be clear: We advocate the continued use of DRM in the protection of our–and our artists’–intellectual property,” Warner Music Chief Executive
Edgar Bronfman
Jr.
Edgar Bronfman Jr.
said Thursday during a conference call to discuss the company’s first fiscal quarter earnings.

The Recording Industry Association of America, which represents all four major labels, also weighed in on Jobs’ remarks. Rather than respond to the demand that the major labels drop usage restrictions, RIAA Chairman and Chief Executive Mitch Bainwol argued instead that Apple
ought to license its iPod technology so that iTunes downloads could be compatible with other digital music players.

“We think that’s a great solution,” Bainwol said in a statement.

But despite this public stance, executives at major labels have been privately mulling whether to drop DRM restrictions on downloads, particularly through non-Apple vendors.

Such a move would have an obvious benefit for non-Apple music vendors, because it would allow them to sell music that consumers could play on Apple’s iPods, which they currently can not do. And because Apple’s online music competitors are primarily focused on selling music via subscription service instead of downloads, it wouldn’t diminish the appeal of their core business–which would continue to use DRM itself.

In theory, a deal could also help lessen Apple’s stranglehold on the digital music market. The company’s iTunes Store accounts for the overwhelming majority of legal song downloads. And the only portable digital music player that plays iTunes downloads is Apple’s market-dominating iPod.

As a result, Apple has been able to negotiate from a position of strength. In particular, the company has been able to insist on a uniform 99-cent price on all song downloads, while the major labels have long sought variable pricing so that they could charge more for the most popular songs and less for other tracks.

But it is unclear what kind of impact keeping or losing DRM restrictions will ultimately have on the ailing music business. Even with DRM, digital sales continue to post rapid growth. According to the International Federation of the Phonographic Industry, digital sales accounted for about 10% of worldwide music sales in 2006, up from about 5.5% the year before. But while that’s a significant advance, it’s nowhere near enough to compensate for eroding physical sales, which still generate the lion’s share of total revenue.

Consider Warner Music, which reported a sharp drop in first fiscal quarter earnings Thursday. Warner said digital revenue represented 11% of total revenue in the three months ended Dec. 31, up from 7% a year earlier. Warner’s digital revenue in the quarter totaled $100 million, up 45% from the same period last year. But total revenue in the quarter sank 11%, to $928 million, while net income plummeted 74%.

U.S. consumers spent an estimated $800 million on digital music tracks last year, according to JupiterResearch Senior Analyst David Card.

Purchases of cellphone ringtones, which record companies also count as digital music revenue, added up to about $870 million, while subscription services, such as RealNetworks’ Rhapsody, Napster and Yahoo! Music Unlimited, generated $190 million. There has been no call to remove DRM restrictions from either of those businesses.

Many consumers probably don’t even notice usage restrictions all that much. Thanks to Apple’s “closed-loop” iTunes-iPod system, getting music from the Web onto a digital music player is already a seamless process for iPod owners.

As a result, Apple’s critics, including the major labels, argue that the company should simply sell its iPod technology to other devicemakers so that they too can manufacture digital music players that can play music downloads from iTunes. Such an approach, like ditching DRM, would promote the “interoperability” of digital music players while also shifting the the burden of action from the major labels to Apple.

“By far, the larger issue for consumers and the music industry is interoperability,” Warner’s Bronfman said Thursday. “As a content company, we of course want consumers to seamlessly access our music and to use the music they have purchased on any platform and with any service, physical or digital.”